Our hashish workforce has carried out due diligence on numerous enterprise purchases, investments, loans, and nearly each different sort of transaction you may think about. As you may think about, we’ve seen some fairly dangerous and even sketchy issues over time. With rescheduling on the horizon (see right here and right here), we count on to see a rise in loans, investments, and different transactions. And so we thought it is perhaps time to have a look at 5 of the largest due diligence crimson flags.
#1 No cooperation in due diligence
Arms down, the largest crimson flag in due diligence is when the vendor, borrower, and so forth. refuses to take part within the course of. I don’t imply getting fatigue when the client or investor’s legal professionals ask too many questions – I imply refusing to take part within the fundamental course of. We’ve seen folks refuse to supply fundamental info. Or stroll away from a deal when fundamental questions had been requested. Or say that different folks did comparable offers with out info, so you must too.
That is all extremely suspect conduct. Somebody who’s promoting a enterprise or in search of a mortgage or funding must be fully open. Clearly, diligence durations can get off the rails and grow to be too lengthy, however failure to supply fundamental info is a crimson flag that one thing dangerous lurks beneath the floor.
#2 When the pitch doesn’t match actuality
One of many subsequent huge crimson flags is when due diligence reveals details that grossly contradict pitches or early disclosures. The due diligence course of often begins as soon as a shopper decides a deal is price pursuing sufficient to pay legal professionals or monetary advisors. That implies that the shopper will count on that what was disclosed to them initially is true. However usually, as soon as attorneys begin to look below the hood, issues can change rapidly. Think about an organization saying it has X quantity of licenses, when actually it has half of that and has merely utilized for extra – stuff like that.
I can’t let you know how upset shoppers can get once they determine this out. A deal can simply die on the spot. If a purchaser or investor fails to do correct diligence, it might not be taught the reality till after the deal closes. Whereas the client or investor may sue for fraud, that cash may simply disappear. It’s significantly better to know this up entrance, earlier than losing money and time.
#3 Unhealthy or loopy enterprise constructions
One other huge factor to search for in due diligence is the goal’s enterprise construction, plans, and organizational chart. In our expertise, the extra sophisticated an org chart or enterprise construction is, the larger the possibility that issues received’t work out (my colleague, Vince Sliwoski, wrote a fairly good submit explaining among the wackier enterprise constructions we’ve seen over time). In some circumstances, over-complexity is utilized in a misguided try to cut back tax burdens or keep away from different issues. But it surely may also be used to straight up confuse and defraud potential buyers. Once more, due diligence is essential.
It’s not simply dangerous or loopy enterprise constructions {that a} purchaser or investor ought to look out for. In addition they want to know essentially what the goal’s marketing strategy is. We’ve seen various circumstances the place a goal claimed to have discovered some hidden loophole within the regulation that meant its enterprise would be capable of nook the market. Generally, a goal will even get a regulation or accounting agency to offer an opinion letter in assist. However these sorts of pie-in-the-sky guarantees hardly ever come to fruition.
#4 Byzantine governing paperwork
Investing in a hashish firm means getting inventory (of a company) or membership pursuits (of an LLC) and turning into an proprietor of the corporate. An excellent reasonably well-governed firm will ask its buyers to signal on to present governing agreements. In circumstances with smaller corporations, an investor might have the possibility to barter new governing agreements, however that’s certainly not a assure. So one of the vital factor an investor can do with respect to due diligence is to have a look at the goal’s governing agreements.
That is one thing that may journey up numerous legal professionals and nearly any lay individual. I’ve seen funding transactions with 80 or 90 or much more than 100 pages of company paperwork slipped into the deal. In case you are not intimately accustomed to company regulation, chances are you’ll miss key provisions that dramatically have an effect on you.
For instance, I’ve seen transactions the place an investor thought they had been going to have the identical rights as different homeowners, however the governing agreements gave them non-voting inventory with no administration rights and a decrease place within the distribution waterfall. This sort of factor may be buried deep inside an working settlement and couched in language that’s extremely dense and difficult to know. This is only one space the place working with good company counsel will pay dividends (no pun supposed).
#5 Possession disputes
One of the vital vital issues to search for is ongoing or threatened litigation. It’s comparatively straightforward to seek out out if a enterprise is concerned in lively litigation (court docket data are public in any case, although they will not be simply searchable). However discovering data of issues like non-public arbitration, mediation, or demand letters could also be inconceivable except the sellers or goal firm discloses that info to the client’s representatives. A step past that, typically there might even be a possible for a dispute, for which no demand letter has been served. Once more right here, a purchaser might want to depend on a vendor to reveal these details.
This can be a little bit of a digression, however the level is that it’s essential to carry out due diligence on a goal’s litigation profile. One space the place litigation can result in disasters includes possession disputes in an M&A (enterprise buy) transaction. Think about an individual is attempting to promote you their enterprise whereas they’re presently embroiled in a lawsuit with an ex-partner who says they had been illegally compelled out and personal half the enterprise (we’ve seen this!).
If a purchaser fails to determine that an possession dispute has or is prone to come up, or does be taught and proceeds with the deal anyway, it’s nearly begging to be named in that lawsuit. If cash was handed over to the vendor, that cash could also be pretty much as good as gone.
Above are 5 of among the largest crimson flags we’ve got seen in hashish transactions when performing due diligence. This listing is certainly not exhaustive, and there are numerous different issues that might tank a deal or result in litigation. We’ll proceed to weblog about all types of company regulation mishaps for the hashish trade, so keep tuned.